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The Trustee’s Lien : X v A, B & C (1999)

Simon Taube – 10 Old Square(taken from Isssue No 10 – January 2000)

Background to the trustee’s lien

In the course of acting as trustee a person may incur liabilities and expenses. As a general rule the trustee is entitled to be indemnified against such liabilities and expenses out of the capital and income of the trust fund. However, the trustee’s right to an indemnity extends only to liabilities and expenses properly incurred.

The trustee’s right of indemnity gives him a first charge on the capital and income of the trust fund. It has priority over the rights of the beneficiaries to receive distributions. The trustee’s right arises by operation of law. Accordingly, even if under the terms of the trust instrument the beneficial trusts have ended and one or more persons are absolutely entitled in possession to the capital (i.e. the trusts are `at home`), the trustee is entitled to retain possession of the capital until his outstanding liabilities as trustee have been discharged or secured.

X v. A, B & C [2000] 01 EG 94

In July 1999 Arden J handed down in open court an anonymized version of her judgment, originally given in private, in X v. A, B & C. The judgment considers a range of interesting points in connection with a trustee’s lien: first, about the circumstances in which the lien may operate; secondly and more importantly, about the administrative consequences of such a lian where the beneficial trusts are at home.

The relevant facts were briefly as follows. The testator died in the 1970s. By his will he appointed X as his sole executor and trustee. He left the income of his residuary estate to his widow for her life and, subject to her life interest, gave the capital to his three children A, B and C in equal shares. His widow had died some years before the hearing, so A, Band C were absolutely entitled to the capital.

During the widow’s life the testator’s land had continued to be used as a sandpit and then filled with rubbish under the supervision of the local authority. The trustee had taken steps to mitigate the environmental risks caused by the rubbish tipping. Those steps required – preventive action to continue for a decade or more in the future. The cost of that action could not at present be predicted with complete accuracy.

In addition, there was a possibility that in future the trustee might be liable to carry out further remediation works to the land under Part II A of the amended Environmental Protection Act 1990 (`the EPA 1990′). Part II A of the EPA 1990 had not yet been brought into force. For four years the Department of Environment had been consulting with interested bodies about the draft statutory guidelines on how Part II would operate. When finalised those guidelines would be published and would clarify the circumstances in which a landowner, and others, might be liable for the costs of remedying contaminated land. There was therefore uncertainty about whether or not the trustee could be faced with contingent liabilities under Part 11 A of the EPA 1990.

The case came to court because the beneficiaries claimed the trustee was acting in breach of trust. The beneficiaries contended the trustee was bound to hand over the trust land and investments to them. The trustee therefore asked the court for directions (inter alia) :

whether it was entitled to retain the trust funds in exercise of its lien to protect it from liabilities (including future and contingent liabilities) in respect of the testator’s land; and

if so, about how it was entitled to manage the trust funds, including

was it free to invest and vary the retained trusts investments inaccordance with the wide power of investment in the testator’s will; and

could it charge for acting as trustee under the charging clause in the will.

Lien for future and contingent liabilities

On the first issue Arden J confirmed that the trustee was entitled to retain the trust fund. (It was on this issue that the case was reported in The Times on 6 October 1999.) The trustee’s lien extended to future potential environmental liabilities which the trustee might never actually incur. For at that date of the hearing it was impossible to know whether or not under the statutory guidelines published pursuant to Part 11 A of the EPA 1990 the trustee would ever be liable.

On this aspect of the case Arden J followed Wilberforce J in Re Pauling’s Settlement (No.2) [1963] 1 All ER 857. In that case Wilberforce J found that an existing trustee had acted in breach of trust and ought to be replaced. The existing trustee contended that it ought to be allowed to retain the fund as security for two matters :

it had appealed to the Court of Appeal; if it won the appeal it would probably need to have recourse to the trust fund to meet its costs, since the beneficiaries would be unable personally to discharge a liability for costs; and

the existing trustee might also be liable for estate duty in respect of past advances to the children of the life tenant, if the life tenant died within 5 years after the advances.

Wilberforce J held that the trustee’s right of indemnity might extend to such matters and therefore refused to replace the trustee immediately or to prejudice its lien.

Role of a trustee’s lien in modern conditions

In modern conditions the trustee’s lien is obviously important. Trustees have commonly exercised the right to retain trust funds to protect them against contingent tax liabilities. Nowadays the most common example is where the interest of a life tenant determines in favour of the remainderman and there is a potentially exempt transfer of value (PET) for the purposes of inheritance tax (IHT). The trustee will be liable to a charge to IHT if the life tenant dies within 7 years of the PET. So the trustee may, in the absence of alternative security, retain part of the trust fund to meet the potential charge to IHT.

The case of X v. A, B & C highlights the importance of the trustee’s lien in the environmental field. Acting in the administration of trust land or a trust business a trustee may be exposed to expensive and long-lasting environmental liabilities. Recent examples include the flooded Cornish tin mines, as well as landfill sites. Insurance against such long tail liabilities is now difficult to find. Even if the beneficiaries are willing to offer to the trustee covenants of indemnity these may not provide complete security. The covenants may prove to be worthless. The long term nature of these liabilities causes them to be inherently difficult to quantify. In many cases a trustee, faced by such potential liabilities when the trusts are at home, may have no alternative but to retain their funds.

Limitation on trustee’s lien

However, there are limitations to the extent of the trustee’s right to retain the trust fund. The trustee must act reasonably. Before he can properly assert the lien he must be able to identify the actual or threatened liability and to show that the value of the retained fund is not excessive when measured against the potential liability. Where there is uncertainty about whether the trustee has acted properly in incurring the liability, this may cast doubt on the trustee’s right to an indemnity out of the trust fund. ButRe Pauling’s Settlement (No.2) (above) indicates the trustee will not be prevented from exercising the lien on these grounds until his impropriety has been fully established.

The continuing administration of the trust fund

So far as 1 am aware until X v. A, B & C there was no learning about the extent of the trustee’s powers where the beneficial trusts are at an end but the trustee is retaining the trust fund in exercise of its lien. Here lies the main interest of the case.

Arden J accepted the trustee’s case that the administrative provisions in the will continued to apply. The trustee’s implied right of indemnity and its associated lien arise by operation of law. These rights exist in relation to the administration of any trust, in the absence of any provision excluding them. The beneficial trusts in the will operate subject to the trustee’s implied rights. It is as if those implied rights were written into the will. It follows that the trustee continued to be able to use the administrative powers and provisions in the will. In X v. A, B & C these provisions included a wide power of investment and a clause authorizing the trustee’s remuneration.

In deciding how to exercise its wide power of investment could the trustee consider its own interests as well as those of the beneficiaries? For example, if the beneficiaries wished the trustee to pursue an adventurous investment policy, could the trustee insist on pursuing a more conservative policy to ensure there were liquid funds to discharge their potential liabilities? Arden J held that the trustee could take its own interest into account as well as the beneficiaries’. But it must act fairly as between the beneficiaries and itself.

A further question arose: before exercising its powers was the trustee obliged to consult the beneficiaries or to comply with their directions? In specified circumstances section 26(3) of the Law of Property Act 1925 or section 11(1) of the Trusts of Land and Appointment of Trustees Act 1996 impose a duty on trustees of land to consult their beneficiaries. Neither section applied in X v. A, B & C. Arden J accepted the trustee’s submission that there was no general duty imposed on a trustee to consult with his beneficiaries.

Does the trustee’s charge depend upon possession?

X v. A, B & C did not have to consider the issue whether the trustee’s right to indemnity and the ancillary charge on the trust fund can survive if the trustee has transferred the trust fund either to the beneficiaries or to a successor trustee.Obiter dicta of Walton J in Stephenson v Barclays Bank [1975] 1 WLR 882suggest that `any lien of the trustee is a possessory lien only and is lost as soon as the property is handed over`. These dicta are at odds with the statement of principle in Snell’s Equity 29th edn. p.456 that the trustee’s equitable lien `confers a charge upon property until certain claims are satisfied …. It exists independently of possession, but will not avail against a purchaser for value of a legal estate without notice of it`.

Recently in the decision of the Federal Court of Australia in Rothmore Farms, Pty Ltd v Belgravia Pty Ltd [1999] FC Australia No 745, 4 June 1999, that court has confirmed that the trustee’s right of indemnity out of the trust fund survives his loss of office, at least where he is replaced by a new trustee; for the right of indemnity not only confers a right to retain possession of the trust property, but `also a property right equivalent to (and ranking ahead of) the interests of the beneficiaries`.

This raises a further interesting question: does the right of indemnity automatically survive if the trustee distributes the trust property to the beneficiary outright without any attempt to preserve expressly the trustee’s rights? In the Rothmore Farmscase the point appears to have been conceded. It might perhaps be surprising if the trustee could recover the distributed property from the beneficiary where at the date of the distribution the trustee had been aware of the liability but not expressly preserved the lien. On the other hand, if at the date of the distribution the trustee was ignorant of the potential liability, why should the trustee have to bear the liability personally, leaving the beneficiary, who is a volunteer, to take the property free from such liability? (These issues will be discussed in a forthcoming paper from the Trust Law Committee on The Proper Protection By Liens, Indemnities or Otherwise Of Those Who Cease To Be Trustees.)

Conclusions

The decision of X v. A, B & C therefore clarifies the law relating to the trustee’s right of indemnity in two important respects. First, it extends to liabilities which do not yet exist and may never exist but which cannot be regarded as unlikely ever to exist. Secondly, a trustee, who is exercising his lien after the beneficial trusts are at home, may still rely on the administrative powers and provisions of the will. But there remains uncertainty about the extent to which the trustee’s right of indemnity continues after he has distributed the property to his beneficiaries.